Big not always beautiful for European private equity

LONDON, March 15 | By Anjuli Davies

LONDON, March 15 Big private equity deals have
been grabbing headlines, but it is the smaller deals in Europe
that are delivering the returns, leaving some investors
pondering the wisdom of pouring more cash into the industry's
giants.

Mid-market European private equity funds delivered average
internal rates of return (IRR) of 17.2 percent in the period
1990-2011 compared with 9.1 percent for all buyout funds,
according to research published this week by the European
Private Equity and Venture Capital Association (EVCA) using
Thomson Reuters data.

"The top performing mid-market managers rely less on
leverage and multiple expansion. Instead, performance comes from
growth and operational improvement," Craig Donaldson of the EVCA
said in the report.

Funds in the mid-market category, defined as those having
raised between 250 million euros ($324 million)and 1 billion
euros, say that performance is prompting increased interest as
investors get more selective about the funds they choose.

"Their targets, medium-sized companies, can be influenced
more easily, making it easier to generate good returns. Also,
the very large PE transactions from the 2006/07 period have not
done so well. Therefore, some investors are not inclined to give
them more money for big deals," Flaig said.

The mega buyout groups are still the ones with the most
available to invest, with an aggregate $122 billion. Large
buyout funds have $96 billion, mid-market $82 billion and small
$47 billion, according to Preqin, which provides data and
research on private equity and other investments.

Asked what fund type offered the best opportunities in 2013,
39 percent of investors surveyed by Preqin said small to
mid-market buyouts, compared to 19 percent who favoured large to
mega buyout funds.

Advent International, which targets companies worth between
200 and 2 billion euros, pulled in 8.5 billion euros in November
in the biggest private equity fundraising since the financial
crisis. This contrasts with rivals more focused on the larger
end of the buyout market that have struggled to reach their
fundraising targets.

STRETCHED VALUATIONS

Some say the returns on larger deals are lower because
competition to win them drives up valuations.

"Investors increasingly doubt that value creation is as big
in large buyout funds as in smaller ones. Auctions often create
unhealthy price levels while small PE groups can often buy
companies directly," Torsten Krumm, partner at medium-sized
German private equity group Odewal, told Reuters.

David Zalaznick, founder and CEO of JZ Capital Partners, a
listed private equity firm which invests in U.S. and European
small companies, said bigger deals tend to go for higher
multiples, "so you have to leverage them more which increases
the risk, or over-equitize them which reduces the returns".

"We like small and medium-sized companies because you can
buy them at lower multiples, they are easier to grow, they are
usually private and often you can buy them away from an auction
process," he said.

In Europe, almost 40 percent of the capital raised to fund
European buyouts flows into the mid-market, with almost a
quarter of all deals involving mid-market firms, says the EVCA.

Andrea Bonomi at InvestIndustrial said Europe was the region
to target as far as mid-market funds were concerned because of
the "attractive valuations that are available and the potential
for GPs (general partners) to make a significant difference to
their investees' performance by helping them to globalise".

The big buyout funds say that, just because they are big, it
does not mean they only do big deals, especially in an
environment where the size of a "large" deal is shrinking.

The head of European private equity at Blackstone
said at an industry gathering in Berlin last month that the firm
was open to doing deals whatever the size.

Investors in private equity firms believe that while some
medium sized groups may have performed well over the shorter
term, the big players have "justified their position" over a 20
year period, Peter Pereira Gray at The Wellcome Trust said in
Berlin.

Another argument in favour of investing in bigger private
equity firms is that they offer scale that big institutions are
looking for given the size of the funds they need to invest.

"You can't look at the IRR as the only measure. The
quantitative dollars that you can deploy in these large funds is
a factor that should be considered as well," David Rubenstein of
buy-out giant Carlyle told the Berlin conference.

"These larger funds - and they do do smaller deals - they do
have the ballast of pretty high qualified people, they're not
likely to break apart, they do get the best managers, the best
deals from Wall Street, the best financing teams so they do have
a lot of advantages." he said.